Cost Reduction in Small-Scale Operations
by Christine S. Pardiñas
So you’ve reviewed your production costs. And so you’ve found you’ve overshot budget again. What is your gut reaction?
Is it:
- To lay off workers to decrease labor cost?
- To compromise on quality of raw materials?
- To skip an “non-essential” production step, like double finishing or inspection ?
- To skip promotion and other marketing activities?
Yeah, right. Like most businessmen, you seem to be sailing a sinking boat. Operating funds are getting scarce, bills are mounting, receivables are piling up, raw materials are getting more expensive, sometimes, more scarce. And worst, competing goods from abroad are being sold dirt-cheap.
To you, the owner-manager or operations head, the most practical solution is cost reduction. Why not? A business operation is all about costs – from raw materials to utilities, advertising and promotion, warehousing and delivery.
But wait, before you start laying off people or buying cheap materials – think again. Do you think doing so would guarantee an effective cost reduction program? Those would save you a fast buck, no doubt. But what about the long-run viability of your business? What happens to your commitment to product quality? Your orientation to customer service?
Rather think new ideas and approaches for better and more effective implementation of a cost reduction program. To produce results, the program must not be haphazard but rather carefully planned and organized.
Cost Reduction Fallacies
Cost reduction is basically an organized and planned method of reducing waste (e.g. materials, man-hours, time, etc.) and reducing expenses in operations in order to improve profits.
You may better understand cost reduction by knowing what it is not.
- Cost reduction is not a series of letters or directives from the owner or manager . Sad to say, this is how most programs are started in most companies. Sure, an order to reduce cost by 30 per cent may be a fine way to start. However, such directives should also be backed-up by organized planning and specific action plans with expected accomplishments. Any series of letters serve only as mere announcements or reminders.
- Cost reduction is not strictly an accounting function . Accounting reports are normally the basis for cost reduction initiatives and these are also the basis for verifying effects of programs implemented. These do not, however, represent a cost reduction program, but rather should be used as tools in evaluating effectiveness of programs.
- Cost reduction is not the management directive which arbitrarily dictates . It is the management general directive which is subsequently disseminated in the organization to be translated into achievable action plans. Shotgun orders reduce costs, yes, but only temporarily. Cost reduction programs should not only be attainable but sustainable as well.
- Cost reduction is not a program based on management or personnel whims and idiosyncrasies . Such an approach indicates unhealthy development of management authority, and even if practiced, would hardly result in a continuing program. Cost reduction programs should be part of the company’s culture – with the participation and commitment of all employees.
Cost Reduction Categories
Cost reduction program in any business operation can be classified into three categories for more effective implementation – waste prevention, operations analysis and innovative ideas. It is within these classifications that an active program can be organized, clarified and communicated within the whole organization.
- Waste Prevention is the conservation of materials, equipment, labor and personnel resources. In short, it is saving on the things used to manufacture products or to provide services. This classification is based on the premise that the best way to avoid waste is to prevent it from occurring in the first place. It is not very difficult to initiate simply because it deals with tangibles, results are immediate, benefits are measurable, and all employees can contribute.
- Operations Analysis , in contrast to waste prevention, is a methodical assessment of all aspects of the business operations. Its purpose is to pinpoint inefficiencies and make improvements, thereby reducing unit costs. Through years of doing business, every company would come to a point where it operates under procedures that are outdated and impractical. Too often, we find processes are followed by force of habit. Operations analysis can initiate a review of existing methods.
- Innovative Ideas . Many companies implement excellent cost reduction programs, but these are usually limited in scope. The ingredient most frequently missing is the organized feed -in of new and innovative ideas from outside sources. Your business may be doing well in itself, but any competitive organization needs to look around to discover new things in order to survive.
Essentials of a Cost Reduction Program
Two words form the key in the development and implementation of an effective cost reduction program – MOTIVATE AND STIMULATE. Business owners or managers need to motivate the employees (as many as possible) to do something constructive about the program. Then, having started them, stimulate them to sustain the activities and come up with new ideas.
The following checklist can guide you in starting a good cost reduction program:
- Development of a program checklist. This involves identification and classification of costs. It also involves procedures to use such as setting objectives, responsibilities, targets, records, and measurement or evaluation policies.
- Form committees in order to identify responsibilities. It is necessary that any contributions by employees be recognized and compensated. .
- Maintaining records of programs. Coupled with identifying responsibilities in specific programs, keeping details of activities, status and accomplishments is equally important. These are necessary in the preparation of accounting and management reports crucial in the planning of company strategies.
- Identification of cost reduction idea sources. Ideas are the very heart of any cost reduction programs. Without tthese, any program would fizzle sooner or later. Ideas may come from various sources e.g. employee suggestions, publications, industry associations, professional consultants, seminars, among others. For proper implementation, ideas can be further classified into active ideas (under study), implemented, and rejected.
- Communication. This is perhaps the most critical portion of implementing a cost reduction program for the simple reason that employees need to be informed of the program itself, the procedures, responsibilities and updates. Cost reduction can operate best when its objectives are fully disclosed.
The ultimate goal of cost reduction is of course higher profits. Most activities will actually be in the direction of lower costs and expenses. However, complete analysis of these activities is required in order to arrive at the most economical project. And sometimes, it is necessary to spend money in order to save money.
(For inquiries, please e-mail info.issi@up.edu.ph.)
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